1 Central banks can do what they like. Traders hang on to central bankers’ forward guidance, placing monumental importance on a catchphrase such as Mario Draghi’s promise to do “whatever it takes” or even a single word. But really, it is no more than guidance. On January 12, the vice-chairman of the SNB told journalists that the EUR/CHF floor “must remain the cornerstone of our monetary policy”. Three days later, he had a change of heart.
2 Stop-loss orders don’t always work. These are orders placed in advance to sell a security when it hits a certain price. In theory, they allow traders to get out of a position before they get burnt, but in volatile markets – when everyone is heading to the same exit and markets jump – traders don’t always get out at the price they want.
They get the ‘best available price’, which, on a day such as Black Thursday, could be a fraction of what they were hoping for. The Swiss franc immediately surged against the euro as soon as the 1.20 peg was abandoned; five minutes later, bid quotes bounced within a 6,000 pip range in two seconds: 1.1078, 0.5696 and 0.9769. A trader with a stop-loss order of 1.1950 would have been lucky to get filled at that rate.
3 Beware sky-high leverage. This is one of those debates that flares up after an event such as Black Thursday, and yet it always seems to die down. It comes back to that old adage: if it sounds too good to be true, it probably is. 100:1 leverage on a currency pair such as EUR/CHF, which posed a very clearly binary risk, was not a smart idea. If you end up lumbered with a trade that is leveraged up to the eyeballs, expect to lose your hat.
Remember that with spread betting, losses can exceed deposits and run into scary numbers. Retail investors that want to play it safe can stick to leveraged exchange-traded funds – you can never lose more than your initial investment.
4 Understand where your liquidity comes from. There are countless forex platforms offering ‘robust liquidity’ that claim to execute virtually all trades within milliseconds, but what happens when markets go haywire? Which liquidity providers is the platform plugged into? The big names in forex are dealers such as Barclays, Citi and Deutsche Bank, and then there are the multi-dealer platforms such as Icap’s EBS and Thomson Reuters’ FX Matching.
Banks can pull the plug on electronic trading and switch to voice trading, so how well connected is the platform to its liquidity providers? Can they pick up the phone and talk to a dedicated FX salesperson at the bank – is anyone even going to answer the phone to them?
|Swiss franc: special focus|
5 Read the small print. Don’t always assume that your trades will be automatically executed, even in this day and age. In hectic markets, a platform might switch to manual execution. What happens to your trade? Will it get executed in an orderly fashion, or chucked into a bucket with everyone else’s trades and executed as and when the platform sees fit at whatever price it deems best? You should be able to find this information in the terms and conditions.
6 Is the platform a market maker? This is important because when markets go nuts the platform has its own principal risk to manage, as well as that of its clients. The Financial Conduct Authority’s 11 principles for business state that a firm must pay due regard to the interests of its customers and treat them fairly, and manage its conflicts of interest. But this doesn’t always happen, even though it should.
7 Research your trading platform. If this sounds elementary, it is. How long has the platform been around, who runs it and, in particular, who head up its risk management?
Take the example of broker Gain Capital. Its chief executive and head of risk management are Glenn Stevens and Tim O’Sullivan, respectively, who between them have decades of experience as currency traders. They’ve seen the good, the bad and the downright ugly.
Last year, they recognized the potential risk challenges posed by the EUR/CHF pair and, by November, had increased customer margin requirements fivefold. The firm made a profit on Black Thursday.